State whether each of the
following six propositions is true or false.In 2-3 sentences, explain why.Use diagrams if helpful.

1.Since the start of the war with Iraq,
the U.S.
military has often complained about the "shortage" of new
recruits.

T, F, and Explain:This is not a "shortage" in the
sense that economists use the word.

TRUE.For economists, a labor shortage is a
situation where – at the market wage
– labor demand exceeds labor supply.The
military's problem, in contrast, is that, given the market wage for wartime labor and its budget, it does not want
to hire additional labor.

The
military's real complaint is that labor is too expensive, not that labor is
unavailable at that expensive wage.

2.Suppose most garbage men have a rare
condition: they lack a sense of smell.Then
someone develops an amazing new gas mask that comfortably protects all people from
foul odors.

T, F, and Explain:The invention of this new gas mask will
make it harder to unionize garbage men.

TRUE.The gas mask increases the supply of garbage
men AND makes that supply much more elastic.Both of these factors make it harder to organize unions.The larger the number of workers in an
occupation, the harder it is to get them all to join the union.The more elastic the supply of workers, similarly,
the greater the tendency of higher wages to attract "scabs" eager to
undercut the union.

3.The government passes a new law requiring
employees to provide workers with free health insurance.Nominal wages are unable to fall, but
inflation is positive.

T, F, and Explain:In the
short-run, everyone who wants to work benefits from this law.In the long-run, however, there will be a
negative effect on employment.

FALSE.In the short-run, workers who remain employed
benefit, but some workers will lose their jobs and have neither income nor
health insurance.The surplus equals the
difference between the new higher supply and the new lower demand at the old
wage.In the long-run, however,
inflation will erode the real value of the nominal wage, and eventually restore
full employment.

4."Malay
and Indonesian slaves were sometimes transported thousands of miles away to South Africa at a time when Africans were being transported
thousands of miles to the Western
Hemisphere." (Thomas
Sowell, Race and Culture)

FALSE.Transporting slaves to locations distant from their homes reduces
enforcement/ monitoring costs for slave-owners.Slaves who are unfamiliar with their area, and who are physically or
linguistically different from locals, will find it harder to escape.As Sowell puts it, "Enslaving people on
their home grounds was more likely to lead to successful attempts at escape
than where they were enslaved far from familiar surroundings."

TRUE.A minimum wage for slaves makes slaves better
off by forcing their owners to give them more than their bare subsistence.This in turn makes slavery less profitable
and reduces the demand for slaves.Since
free workers are a substitute for slaves, demand for free labor goes up, making
free workers better-off and their employers worse off.

(Many
students' incorrectly assumed that the minimum wage applied to both slaves AND
free workers.I gave these answers
partial credit).

6.The estimated return to education falls after
controlling for intelligence.

T, F, and Explain:If you
take tuition into account, this shows that educating the less intelligent is
especially likely to be a bad investment.

TRUE.Students pay the same tuition regardless of
intelligence, but more intelligent students get a larger total benefit, implying a higher rate of return.

Consider
this simple example: Students with average IQ earn $20,000 without a college
degree, and $22,000 with a year of college.Students with high IQ earn $30,000 without a college degree, and $33,000
with a year of college.Ignoring
tuition, the return to education is 10% for both groups.However, if tuition costs $10,000, average IQ
students have a return of $2000/($20,000+$10,000)=6.7%, and high IQ students
have a return of $3000/($30,000+$10,000)=7.5%.

Part 2: Short Answer

(20 points each)

In 4-6 sentences, answer both of
the following questions.Use diagrams if
helpful.

1.In Economic
Sophisms, Bastiat writes:

If
man were a solitary animal, if he worked solely for himself, if he consumed
directly the fruits of his labor—in short, if he did not engage in exchange—the
theory of scarcity could never have been introduced into the world.

Use two labor supply and demand diagrams to show that what Bastiat
calls the "theory of scarcity," may be true for a single occupation, even
though it is false for the economy as a whole.Carefully label both diagrams.

In
a single occupation, a fall in workers' MPP increases
MVP – and labor demand – as long as product demand is relatively
inelastic.In one occupation, then,
lower productivity can increase wages and make workers better off.In contrast, for the economy as a whole, a
fall in workers' MPP always decreases MVP.For the economy as a whole, then, lower productivity automatically
reduces average wages and makes the average worker worse off.

2.What is the difference between "externality"
arguments for subsidizing education and "credit market imperfection"
arguments for subsidizing education?Discuss
one kind of evidence that undermines one argument, but not the other.

According
to "externality" arguments, when a person gets more education, there
are positive side effects for society – like less crime or better voting.In this scenario, the private return of
education is normal, but the social return is unusually high.According to "credit market
imperfections" arguments, in contrast, education has an unusually high private return because – due to
collateral problems – it is hard to get an educational loan.

Controlling
for IQ undermines the credit market imperfections story by showing that the
private return to education is not as high as it looks.But controlling for IQ does not undermine the
externality story, because the externality story does not predict abnormally
high private returns for education in the first place.